Cost Segregation and Bonus Depreciation Explained

Owner's answer

What is cost segregation?

Cost segregation is a tax study that splits a building's purchase price into parts with shorter tax lives. More of the cost is then depreciated sooner. If you own the building, you or your accountant commission the study.

In a syndication, the sponsor decides whether the partnership orders one, and you see the result on your K-1. A study sorts the cost into three groups:

• Personal property with a 5- or 7-year recovery period.
• Land improvements such as fences, roads, sidewalks and shrubbery, which are 15-year property.
• Everything else in the building, which stays on the 27.5-year (residential) or 39-year (nonresidential) schedule.

Land is never depreciated. IRS examiners review these studies with the Cost Segregation Audit Techniques Guide (Publication 5653, February 2025), so the split has to be supportable.

How does real estate depreciation work?

Real estate depreciation is a yearly deduction for the cost of a building, spread over a recovery period set by the tax code. Buildings are depreciated straight-line with a mid-month convention, which treats the property as placed in service halfway through its first month.

Hotels and motels where more than half the units are rented to transient guests don't count as residential rental property. They fall on the 39-year schedule.

2026 rates

Is 100% bonus depreciation available in 2026?

In 2026, 100% bonus depreciation is available for qualified property acquired after January 19, 2025. The 2025 tax law, the One Big Beautiful Bill Act (Pub. L. 119-21), restored the 100% rate permanently and struck the old phase-down. That is the big beautiful bill bonus depreciation change. Property acquired before that date still follows the phase-down.

The acquisition date is the date a binding contract was signed, not the closing date. Notice 2026-11 is interim guidance: until final rules arrive, taxpayers may generally rely on the existing bonus depreciation regulations with the new dates.

A taxpayer can also elect out of bonus depreciation for a whole class of property. Older articles that quote a flat 20% for 2026 describe only property under contract before January 20, 2025.

Cost segregation vs bonus depreciation: what is the difference?

Cost segregation finds the parts of a building with short tax lives, and bonus depreciation lets those parts be deducted in the first year. They work as a pair, because bonus depreciation only applies to property with a recovery period of 20 years or less. Without a study, almost the whole building stays on the 27.5- or 39-year schedule and bonus depreciation has little to apply to.

Bonus depreciation never applies to the building shell. The 2025 law also created a 100% deduction for "qualified production property." That covers manufacturing buildings, not property leased to tenants, so it does not help a rental syndication.

Worked example

How does cost segregation show up on an LP's K-1?

Cost segregation shows up on a limited partner's K-1 as a bigger share of early-year depreciation. It usually sits inside the box 2 rental loss. The partnership makes the depreciation elections (IRC 703(b)), so each investor receives a share of whatever the deal claims.

A larger year-one deduction is mostly a timing change. Every dollar of it lowers your basis, and the tax comes back when the property sells, as the recapture band below shows.

Using the loss

Can real estate depreciation offset W-2 income?

Depreciation from a syndication generally cannot offset W-2 income, because a limited partner's rental loss is passive and passive losses only offset passive income. An unused loss waits, carried forward, until you have passive income or sell your entire interest. The K-1 guide covers whether K-1 losses offset W-2 income, including the real estate professional test and why it rarely fits a limited partner.

Relli co-founder and CEO Mor Milo puts the appeal this way.

"Depending on the way that you invest in real estate, you have something called depreciation that gives you a lot of opportunity to reduce your tax burden."

Mor Milo, Relli co-founder and CEO, in Can Real Estate Investments Offer Tax Benefits? (May 14, 2026)

In the same clip he adds that the benefit depends on the deal's structure and that investors should talk to a certified public accountant (CPA) first. This page explains general rules, not tax advice for your return.

Recapture

What is depreciation recapture?

Depreciation recapture is the tax at sale on depreciation you deducted while you owned the property. Each year's depreciation lowers your basis, so more of the sale price becomes gain. The tax code taxes the depreciation part of that gain at its own rates.

In a syndication the deal sells the property and the gain flows to you on the final K-1, with the building's share in box 9c. If you sell your partnership interest instead of waiting for the sale, a look-through rule (Treas. Reg. 1.1(h)-1) applies the same treatment.

Is depreciation recapture ordinary income?

Depreciation recapture is partly ordinary income. Depreciation on short-life personal property is recaptured as ordinary income under IRC 1245. That covers the 5- and 7-year items a cost segregation study finds and bonus depreciation writes off. Straight-line depreciation on the building is unrecaptured section 1250 gain, taxed at no more than 25%.

The table shows the trade-off. A $10,000 deduction saves up to $3,700 if it offsets income taxed at 37%. If that $10,000 came from short-life property, it can cost up to $4,080 at sale. If it came from the building, the cost is up to $2,880.

Accelerated depreciation mostly defers tax, and it can turn gain that would have been capital gain into ordinary income. Owners who sell a property outright can keep deferring tax with a 1031 exchange. That route generally does not work for a syndication LP interest.

Judging the claim

Is cost segregation worth it?

Cost segregation is worth it when the faster deductions can actually be used and the tax at sale is planned for. For a building owner it is mostly the study's cost against the deductions it brings forward. For a limited partner, three questions decide it:

• Can you use the losses now? Without other passive income, they sit until the deal sells.
• How long is the hold? The sooner the sale, the sooner the deferred tax comes due.
• What is your rate now versus at sale? Short-life recapture is taxed at ordinary rates.

How do you check a sponsor's depreciation claims?

A sponsor's depreciation claims can be checked against the purchase contract, the study and the offering documents. Ask these before you invest:

1. Will the deal commission a cost segregation study, and who will prepare it?
2. When was the purchase contract signed? Only property acquired after January 19, 2025, gets 100% bonus.
3. Does the partnership plan to elect out of bonus depreciation or take the 40% election?
4. What year-one loss do you expect per $100,000 invested, and what is it based on?
5. What does the projection assume about recapture and taxes at sale?
6. Which states will investors file in, and do those states follow the federal bonus rules?

Treat any projected loss as an estimate, not a promise. Oil and gas programs work differently: drilling deals pass through intangible drilling costs (IDC), which follow their own deduction rules.

Short answers

Does bonus depreciation reduce your basis, and is it optional?